On Monday, my Bloomberg View colleague Mark Gilbert explored a fretful question: Are we in the midst of yet another asset bubble? Stanley Druckenmiller, who helped George Soros “break the Bank of England” in 1992, thinks we are. In a speech earlier this year, he said he’s got the same bad feeling he had in 2004. The culprit is the same in both cases: the Fed, blowing asset bubbles, beautiful asset bubbles, with excessively loose monetary policy.

Gilbert ably summed up Druckenmiller’s remarks and the reasons to be worried about frothy asset prices, so I won’t try to replicate his fine efforts. Like Druckenmiller, I think there’s evidence that investors are “reaching for yield,” pushing into riskier investments in an attempt to reap the higher returns they got used to.

This is exactly what investors are doing, and they wouldn’t behave this way if the federal reserve hadn’t lowered the federal funds rate to zero and flooded the economy with cash. Too much money chasing too few opportunities is a recipe for mal-investment and asset bubbles.

Instead, I’ll focus on a different question: How much is the Federal Reserve really to blame?

Who else could possibly be to blame? Nobody else has the endless bucket of cash required to push interest rates up or down at will. The federal reserve printed nearly $4 trillion — that’s trillion with a “T” — to inject money into the economy through bond purchases that lowered yields to zero. Not even Warren Buffet has $4 trillion at his disposal.

It is received wisdom among many Wall Street professionals — and the majority of conservatives of my acquaintance — that the Fed’s monetary policy is capable of producing massive asset price bubbles. And it did so in the late 1990s in the stock market, then again in the housing market.

The federal reserve was more involved in the late 1990s stock market bubble than they were in the housing market bubble. The stock market bubble was caused by excess liquidity in the system as Alan Greenspan freaked out of Y2K, but the housing bubble was not inflated by excess federal reserve liquidity. The lowering of mortgage rates may have served to precipitate the bubble, but the actual effect of lower rates only accounts for 10% to 15% of the rise in house prices. The remaining 85% was due to toxic loan financing, particularly the Option ARM.

Many charts have been made juxtaposing the Fed funds rate and the S&P 500 or the Case-Shiller index. I expect many more will be produced in the years to come. But I am not sold on the value of these charts, because they don’t give me a mechanism. How does mispricing a single short-term interest rate cause investors to go mad and start wildly speculating on stocks and housing loans?

Her lack of understanding of basic economics is embarrassing. Mispricing short-term interest rates forces investors to abandon long-held investment criteria because no opportunities make the grade. Investors must lower their standards in order to deploy their funds or they end up sitting on piles of cash earning nothing. This problem is exacerbated by the federal reserve when they flood the economy with cash. The problem is so bad that most commercial banks leave this cash sitting on account at the federal reserve.

I’m not arguing that there is no effect. There is obviously some, because debt markets are connected. People borrow short to lend long all the time (that’s how your bank makes money — your deposits are essentially a revolving credit line that can be withdrawn at any time). When the Fed engages in open-market operations to manage the supply of money, it changes the market’s supply of government bonds. All these things have ripple effects that are felt across many asset markets.

Someone must have explained to her the basic mechanizations because everything she states above is correct.

But the case for placing most of the blame on the Fed seems to assume that these ripples are more like tidal waves, swamping any other considerations, such as whether those dot-com companies are ever going to make any more or whether people are going to be able to repay those mortgages you just underwrote. That seems extreme.

Whether it seems extreme or not, that’s what happens.

To put it another way, as I’ve remarked from time to time, if financial markets are really so stupid that keeping the Fed funds rate too low can cause the majority of investors to lose their minds and start pouring money into stuff that is unlikely to ever return their capital, much less a profit, then conservatives are wrong and free markets don’t work, and we should just abandon the whole project.

Duh! Wake up! We abandoned free markets several years ago when the federal reserve took control of the entire economy. What we should abandon is the federal reserve’s control of the economy through flooding capital markets with cash it doesn’t want and can’t use effectively.

Ben Bernanke himself made this point in a 2012 speech. Of course, he would say that, wouldn’t he?

No kidding?

But he made some other convincing points — noting, for example, that the housing bubble was international and seems to have started building in the late 1990s, when Fed policy wasn’t all that loose.

There isn’t much convincing about that statement because it’s factually erroneous. The US housing bubble began inflating in 2003 when toxic loan products became the norm. Most countries around the world embraced some form of financial innovation that proved so disastrous here, and they suffered the same dreadful results.

Yes, Fed policy is very powerful in the global economy, and maybe (probably?) threw fuel on the fire. But is it really so powerful that it dominated loans made in other currencies whose central banks were running tighter monetary policies? This seems like a stretch.

She fails to understand the mechanism here. When the federal reserve lowered interest rates in 2001 and kept them there for several years, investors sought more creative way to find yield. They embraced any investment opportunity that appeared to provide a superior return for the perceived risk. Mortgage loans looked safe; after all, house prices only go up, so toxic loan products offering superior yields were eagerly embraced, and the flood of money through these toxic loans inflated house prices. The federal reserve didn’t directly cause the housing bubble, but they certainly did create the conditions that fostered it.

But what’s the alternative explanation? Bernanke hinted at it in his speech: global capital flows, or what he has called the “global savings glut.” Too much money is chasing too few investments.

I always cringe when I hear this described as a global savings glut. It was a global liquidity glut caused by loose monetary policy. The results were the same: too much money chasing too few investments, but it wasn’t because prudent citizens were saving too much money.

Perhaps these flows can be increased or decreased by government policy, but they also have a strong, independent life of their own. They may get some help from the Fed and other central banks, but they don’t necessarily need it.

Central banks like the federal reserve aren’t necessary for asset bubbles, but loose monetary policy makes them easier to inflate and much more common.

For now, I’ll just note that even if Bernanke is right, that still doesn’t mean that Druckenmiller should be any less worried. Two bubbles in a row is troublesome. If we’re indeed in a third, that starts looking more like a trend — and not a good one.

What it does mean, however, is that we don’t necessarily have great tools to fight an emerging trend. Blaming the government posits an easy policy solution: Stop doing the stuff that is causing the bubbles.

Yes, this is exactly what should be done. As long as we live in a world where private savings have no value and where the central bank provides unlimited amounts of investment capital at whim, then we will have frequent, painful asset bubbles.

But if an excess of global savings over global investment opportunities is the main issue, what exactly are we supposed to do to stop that?

An excess of global savings is not the problem, so if the problem is defined improperly, then any solution derived will be ineffective. If the problem is defined as a global savings glut, the remedy would be to lower interest rates below zero to disincentivize saving — which some kooks suggest. The evidence of the last several years shows this is clearly not the answer.

We need to restore value to private savings by allowing interest rates to rise. If interest rates on savings were at reasonable levels, all other investments would pay higher yields, and the distorting effect of zero percent interest rates would not cause a string of asset bubbles. Unfortunately, given the deflationary pressures of trillions in bad debt still lingering in the economy, and given the excessive debt burdens carried by most families, raising interest rates simply isn’t possible right now — and it may not be for the foreseeable future.

Realistically, when you contemplate where we are in financial history, we are embarking on the great era of financial bubbles caused by loose monetary policy. These bubbles will dominate the financial landscape for the next few decades. The financial elites and a few lucky or wise investors will profit from the unnecessary volatility, but overall most will suffer until we put a stop to it.

Housing prices are high by comparison to both rents and incomes, and the opportunity cost of holding real estate is rising. Indeed, as China eases caps on bank deposit and lending rates, the rise in the effective discount rate poses a particular threat to high asset prices.

In other words, just like in he US, the lack of competing investment alternatives forced families to chose between overpaying for real estate or allowing their money to sit idle and earn nothing, and since Chinese view their real estate as a “can’t lose” investment because “real estate only goes up,” The Chinese inflated an unbelievably massive housing bubble.

But high price-rent ratios exhibit knife-edge sensitivity to changes in both projected rent growth and the discount rate. To see this, imagine a price-rent ratio of 50 based on a projected rental growth rate of 4% and a discount rate (including both the risk-free rate and the housing risk premium) of 6%. Either a one-percentage point drop in the expected rate of rental growth to 3% or a one-percentage point rise in the discount rate to 7% would slash the warranted price by nearly one third.

So just like here in the US, if yields on competing investments rise, the value of real estate crumbles because investors will sell real estate in order to obtain the higher returns in other investments.

Perhaps the most important concern is the likely rise in the discount rate that households use to assess the benefits of holding assets of any kind, including housing. For decades, China severely limited the return to holding bank deposits. That financial repression made housing ownership a key instrument for personal savings. The rapid expansion of shadow banking since 2008 amounted to a partial relaxation of these restrictions. And policymakers continue to move in this direction with the introduction of deposit insurance next month. If (and when) banks are able to pay a competitive market rate on deposits, housing will face far more serious competition for household savings.

This will leak the air out of China’s real estate bubble. They must hope it is only a slow leak rather than a pop.

Twenty-three years seems like a long time to wait, particularly given record low rates.

Japan is the textbook example of what can happen if the bubble becomes so large that even zero percent interest rates can’t make the debt service manageable.

We are fortunate here in the US that we only inflated house prices to double their fundamental value. By cutting mortgage rates from 6.5% to 3.5% and allowing rents to rise over time, we managed to raise values high enough to allow the banks to roll over their bad debt from the bubble into more stable debt today. It’s taken 10 years, but we are almost there. In Japan, they inflated an even larger bubble, and they also had demographics shifts working against them, so it took much longer to reflate their bubble even with mortgage rates half of our record low.

What the FED and many CBs did was mis-pricing bond risk by their massive buying. Investors has no choice but to buy stocks and RE for the risk is better when adjusted for rewards. Thus the bigger bubble is in bond and not other assets when you see governments just borrow more and more after year to spend on useless and social programs [with zero meaningful plan to reduce debt] while rates keep going down making the false appearance that the the debt is serviceable. Rates [long term] will go up when investor realize that they’re sitting on paper [bond] backed by nothing and the risk of a haircut or default is getting more real. That’s partially explains why stocks has been going up in the face of weakening fundamentals beside the usual bad news is good news meme and even when QE has been stopped for months in the US.

The stock market has been fascinating to watch lately. A big part of the rally was fueled by stock buy-backs as companies refinanced their old debts at super-low rates, and lacking other investment opportunities, they started aggressively buying back their stock to drive up the company valuation. This flow of funds is the indirect result of federal reserve policies, but it certainly would not have occurred if the federal reserve hadn’t flooded the financial markets with cheap debt.

The flow of funds from stock buy-backs has slowed lately, and mom-and-pop investors picked up the slack. This tells me a deep correction is forthcoming as those weak hands get forced out of the market.

Not sure that mom and pop is fully back yet. They might never will due to the lost confidence in the stock market in general. I was a trader for a short time and I can see that volume is much lower than pre 2008 when mom and pop were fully dabble in the market. The rise so far has been very professional. Many traders make very little money these days due to the low volatility so I can’t imagine that there are many of them around. Short sellers (includes hedgefunds) are also devastated by this rise so they’re are out as well. What we have left might be pensions chasing yields, buybacks, and large private investors including sovereign wealth funds aka the big players.

If the market is dominated by professionals, it will be less volatile and prone to changes in their investment criteria and incentives. It’s when the public starts trading that all hell breaks loose. They usually wait until the trend has runs its course before they feel enough “safety” in the momentum to buy in, and at the first sign of trouble, they all stampede for the exit and get burned.

Tesla Motors (TSLA), the company that plans to revolutionize automobiles with its electric car, is planning a new revolution that aims to transfer how we power the rest of our lives.

The company plans to begin selling a battery that can be used to power a home and is expected to officially announce the home battery in the next few days, according to a report from The Los Angeles Times (via The Hamilton Spectator).

According to the report, Tesla has begun briefing environmental groups and analysts on its plans.

From the LA Times report:

Storing electricity efficiently, inexpensively and safely is a problem that has vexed the power industry since electricity was first harnessed. But such storage has huge implications for bolstering the national electricity grid and reducing pollution from power generation.

Homeowners and businesses, for example, could charge batteries at night, when there is surplus generation and rates are cheap, and then use the power during the day, when there is a heavy load on the grid and rates are highest.

“You can look at the battery as an asset on the grid and then you can start to figure out the financial opportunities,” said Rajit Gadh, director of the Smart Grid Energy Research Center at the University of Southern California, Los Angeles.

In response to The Wall Street Journal’s article on confused policymakers dealing with a glut of capital, Mises Canada’ Patrick Barron briefly summarizes their errors…

The worldwide commodity glut is not a surprise to Austrian school economists.

It is a wonderful example of the adverse consequences of monetary repression to drive the interest rate below the natural rate.

Longer term projects, such as expansion of mineral extraction, appear to become profitable. But such is not the case for the simple reason that printing money does not represent an increase in real, saved resources.

Eventually it will be clear that capital has been wasted, what Austrian school economists call “malinvested”.

No amount of further monetary repression can cure this problem, although I am certain that the Keynesian school economists in charge of central banks and governments all over the world will give it a good try. Akin to bleeding the patient until he recovers, we may not survive this Keynesian medicine.

* * *

Simply out – Austrian economists understand full well why there is a commodity glut but what they don’t understand won’t stop them…

* * *

As we concluded previously, in the end, central banks will continue to keep conditions loose, seemingly oblivious (or perhaps willfully ignorant) to the fact that low rates and booming equity markets are contributing to the supply glut without effectuating a concomitant increase in demand. Meanwhile, producers — such as heavily indebted US shale companies — are forced to keep producing in order to keep what little revenue is still coming in flowing, a dynamic which is exacerbated when companies take on debt (and thus more interest expense) to stay alive:

Even if governments have the capacity for more fiscal stimulus, few have the political will to unleash it. That has left central banks to step into the void. The Federal Reserve and Bank of England have both expanded their balance sheets to nearly 25% of annual gross domestic product from around 6% in 2008. The European Central Bank’s has climbed to 23% from 14% and the Bank of Japan to nearly 66% from 22%…

Producers have their own share of the blame. In a lower commodity price environment, producers typically are reluctant to cut production in an effort to maintain their market shares.

U.S. home prices for February were up by 4.6 percent year-over-year and 0.7 percent for the month, according to a home price index (HPI) report released by Black Knight Financial Services this morning. This is the largest monthly gain in home prices since June of last year.

The report also revealed that the national HPI level is now just 9.5 percent shy of its all-time high of $268,000–reached in June 2006. The HPI currently sits at $242,000.

Top moving metros month over month included several cities in California–San Jose, San Francisco, Napa, Santa Cruz and Santa Barbara.

Now is the Optimal Time for Homeownership Due to Low Interest Rates, Anticipated Appreciation

Due to current low interest rates and anticipated appreciation rates for the next few years, homeownership is “one of the last legitimate wealth creation opportunities,” according to Tim Rood, chairman of Washington, D.C.-based business advisory firm The Collingwood Group in an interview with Westwood One radio host Dirk Van last week.

“The leveraged return if you put down 10 percent on a house, the trajectory of appreciation lately is you’re going to get your money back inside of a year and then after that 5 to 10 percent appreciation rates,” Rood said. “It’s phenomenal.”

“(Low inventory) makes for a pretty compelling case to get in now when you can lock in rates as low as they are, and still from what most of the forecasters anticipate, you’re going to see 4 to 5 percent appreciation for the next three to four years, which is pretty impressive to say the least,” Rood said.

[Sadly, people base financial decisions on nonsense like the spout above.]

Death Taxes: I suggested renaming the gasoline tax as a “usage fees on America’s transportation network,” observing that it wasn’t as catchy or misleading as the use of the phrase “death tax” to describe the levy on the estates of deceased multimillionaires.

Several of you wrote to complain that my characterization of the phrase “death tax” was an act of linguistic subterfuge. So let’s look at the data to see what it suggests.

In 2013, 2,596,993 Americans died, according to the Centers for Disease Control and Prevention.

About 5,000 of them paid a tax after that mortal event. To be more accurate, their estates paid whatever tax was owed. That means 2,591,993 Americans died that year without paying any tax.

In other words, just 0.19 percent of all deaths in 2013 resulted in a tax. When 99.81 percent of all deaths don’t create a taxable event, calling it a death tax is mathematically nonsensical.

What is the actual trigger for this taxable event? If your estate is worth less than $5.43 million dollars in 2015 (or $10.86 million dollars for a couple), you are exempt from the federal estate tax. Over that and your estate pays. Unlike the gasoline user fees that pay for bridge and highway maintenance and construction, the estate tax is indexed for inflation.

Why would someone use the phrase “death tax” when more than 99 percent of deaths don’t result in a tax? Because he is either a) innumerate, b) ignorant or c) trying to deceive you. There are no other possibilities.

Maybe we should start referring to the income tax as the “labor tax”? Or maybe the “time tax” since you have to spend your day earning the income that is taxed? We can then label the capital gains tax the “fat cat tax.”

The so-called markets (including housing) are no longer indicators of ANY economic realities; ie., without CB’s around the globe essentially going all-in to monetize everything just to keep dead men walking, bids would simply vanish at current price.

The market will be soaring when the next collapse commences, especially in the bubble counties.

Agreed. I was shocked to see that there is only one townhome/condo for sale in the ENTIRE zip code where my HB condo is located. That is absolutely unheard of. Usually there are 10-20 for sale at any given time. This tells me the “starter” home market is suffering from a severe supply shortage.

My primary is situated similarly. There are only 8 houses for sale in the entire zip code… less than one per housing tract. The recent pendings are listed for about 15% higher than the appraised value I received in November, so we’ll see where they close at, but it’s shocking to see this kind of activity, even to me.

The entry level supply shortage started in late 2011 when foreclosures stopped. It got worse as lenders stopped approving short sales. I assume what you are seeing is even more construction of supply? What do you think is causing such an extreme dry up of supply?

I think you have pointed out before that the economics of home building favor either luxury buyers or large multi-family developments. Entry level doesn’t pencil out for new construction. So none of the new supply in Irvine/South OC is geared towards first time buyers and they are stuck picking over existing inventory. When you remove high-end luxury condos from the totals, there really isn’t much supply. Maybe this is where affordability products make their big comeback.

When Jim Grant was once asked ‘how should one value gold?’, he proposed that the value of gold probably is ‘1/N’, with ‘N’ standing for the faith people have in the monetary authority. The more this faith declines, the higher the price of gold will go.

The Speculative Investor, Steven Saville:

Gold benefits from the negative effects of monetary inflation rather than the monetary inflation itself. The most important of these negative effects is economic weakness stemming from mal-investment, which will usually prompt additional monetary inflation.

For this reason, inflation policy (central bank “money printing”) will not be helpful to gold in real terms while the policy is generally perceived to be working. Unfortunately, there’s no way of knowing ahead of time precisely how long it will take before the wealth-destroying aspects of the monetary inflation will become apparent to a critical mass of people.

Many gold bulls pay minimal attention to the legitimate reasons for being bullish and instead fixate on aspects of the market that have no bearing on whether gold’s future price trend will be bullish or bearish.

The fact that gold bulls conveniently ignore is that gold massively outpaced inflation from 1999-2011, and until either inflation catches up with gold, or gold drops to the level of real inflation, there won’t be any end in sight to this bear market. Buckle up. More pain is coming.

Labor costs, technology, and fuel costs necessary to extract gold. There is close to an infinite supply of gold in the Earth. Actual supply just depends on how much resource you invest into extracting it.

Labor costs, especially the low end labor working in mines have not kept up with inflation.

Technology has gotten significantly cheaper.

While fuel has gotten more expensive, this is offset by machinery that is more fuel efficient.

I’m will Mello Ruse on this one. When I first read MJB’s comment, the first thought that came to mind is that gold bugs haven’t capitulated yet. Until they all give up, the bottom will not happen. Even after capitulation, prices may languish near the bottom for many years. Once everyone completely forgets about gold, then prices will hit cyclical lows.